Social Security loophole’s huge windfall opportunity

Robert Klein, CPA, PFS, CFP®, RICP®, CLTC, MBA, MST is the founder and president of
Retirement Income Center, a
retirement income planning firm located in Newport Beach, Calif. The firm
specializes in innovative, conservative income management strategies in addition
to offering traditional investment management services designed to help clients
achieve their retirement income planning goals. Bob is also the sole proprietor
of Robert Klein, CPA, which he founded in 1989. In addition, he is the writer
and publisher of Retirement
Income Visions, a weekly blog featuring innovative strategies for creating
and optimizing retirement income, and previously wrote and published Financially
InKlein’d. Bob has been quoted and featured in various publications, including The Wall
Street Journal, Yahoo! Personal Finance, InvestmentNews,
Financial Advisor Magazine, Bankrate.com, AnnuityNews, Wells
Fargo Small Business Roundup Newsletter, Wealth Manager Magazine and Retirement
Income Journal. Bob can be
reached via his website, Retirement Income Center,
LinkedIn and
Twitter: @IncomePlanner.

As a seasoned CPA, I remember the good old days when there were lots of loopholes in the tax law that I could use to minimize clients’ income tax liability. I also value opportunities to help my clients maximize their Social Security benefits.

Like tax loopholes, they’re often not obvious and require intimate knowledge, familiarity, and understanding of intricate rules and regulations.

For instance, you might be surprised to learn that the file-and-suspend strategy isn’t limited to couples.

There are various strategies that can be used to maximize Social Security retirement benefits. One of the most popular, though not in favor with the current administration, is the file-and-suspend strategy. It’s been touted for years as a way for married individuals to maximize their benefits as a couple.

For those of you who may not be familiar with the file-and-suspend strategy, it allows a couple at full retirement age (66 to 67 depending upon when you were born) to increase each individual’s worker’s benefit by 8% annual delayed retirement credits for each year that the benefit start date is deferred until age 70 — while triggering a spousal benefit for one individual. This is accomplished by one of the spouses, generally the one with the higher benefit assuming unequal benefits, applying for his/her worker’s benefit and then immediately filing a notice to suspend payment of his/her benefits. This allows the other spouse to file for his/her spousal benefit which will equal 50% of the filing and suspending spouse’s benefit.

It turns out that the use of the file-and-suspend strategy isn’t limited to couples. According to Mary Beth Franklin, a contributing editor on retirement, tax, and Social Security issues for InvestmentNews since 2011, single individuals can also use this strategy. She recently shared her research with several hundred attendees at a recent Orange County, Calif. Financial Planning Association quarterly meeting. Mary Beth is one of the nation’s leading authorities on Social Security and is my go-to person on this subject.

How can single individuals take advantage of the file and suspend strategy? Suppose that you’re single and you either (a) don’t plan on retiring until a post-full retirement age, 70, or (b) you retire at 65 and have sufficient assets and income to live on between 65 and 70, allowing you to defer your Social Security start date to age 70 to take advantage of the 8% annual delayed retirement credits. You can file for benefits at your full retirement age and then immediately file a notice to suspend payment of your benefits.

Single individuals can insure their retirement benefits

What is the purpose of filing and suspending retirement benefits if you’re single? Per Mary Beth’s research, this enables you to go back to the Social Security Administration before age 70 to request payment of a retroactive lump sum of monthly benefits that you would have received had you started collecting benefits when you reached full retirement age. This is spelled out in the Retirement Planner: Suspending Retirement Benefit Payments section of Social Security’s website:

“If you change your mind and want the payments to start before age 70, just tell us when you want your benefits reinstated (orally or in writing). Your request may include benefits for any months when your payments were suspended.”

While you would forfeit a 24% to 32% (8% a year x 3 or 4 years depending on whether your full retirement age is 66 or 67) increase in benefits that you would receive for the rest of your life beginning at age 70, you would instead receive a sizable windfall.

Assuming that you qualify for a maximum monthly retirement benefit at age 66, which is currently $2,642, file and suspend at age 66, and make your retroactive benefit payment request a month before your 70th birthday, you would receive a lump-sum payment of $126,816 ($2,642 x 12 months x 4 years) plus cost of living adjustments, or COLAs, for the last four years. In addition, you would begin receiving monthly benefits of $2,642 increased by cumulative COLAs since your full retirement age plus future COLAs for the rest of your life.

This provision allows single individuals who intend to defer their benefit start date beyond full retirement age to insure payment of their full retirement age benefits in the form of a lump sum in case they change their mind between full retirement age and age 70. While it isn’t limited to this situation, as Mary Beth pointed out, it would be invaluable if you learned at age 69 that you had terminal cancer.

Couples can also insure retirement benefits of one spouse

Although the file and suspend strategy hasn’t historically been applied this way, couples who are at full retirement age can use it to insure a lump-sum payment of full retirement age benefits for the filer and suspender. Suppose that one spouse files and suspends for the purpose of increasing both individuals’ worker benefits by 8% annual delayed retirement credits between full retirement age and 70 while enabling the other individual to collect a 50% spousal benefit during this period.

Just like the single individual, the filer-and-suspender can change his/her mind and request payment of a retroactive lump sum of monthly benefits that he/she would have collected had benefits been received between full retirement age and 70. This would be trickier with the terminal cancer situation since it would be of greatest benefit financially for the couple only if the filer-and-suspender is diagnosed with this disease. The other spouse, though, who was collecting a 50% spousal benefit would not be able to apply for payment of a retroactive lump sum of monthly benefits since he/she never filed and suspended his/her benefits.

Beware of income taxes and increased Medicare Part B premium

When deciding if it makes sense to apply for payment of a retroactive lump sum of monthly benefits, federal and state income taxes must always be kept in mind. When the total of your adjusted gross income, nontaxable interest, and one-half of your Social Security benefits exceeds a relatively low threshold ($25,000 if single or $32,000 for married filing joint), 50% to 85% of your benefits are taxable depending upon the amount of your combined income.

While most taxpayers who use the file-and-suspend strategy exceed Social Security’s income threshold, this isn’t always the case. The addition of a lump-sum payment of $127,000 per the example would generally result in taxation of 85% of this amount, unless offset by an allowable loss of a similar amount from some other source. Depending upon the amount and sources of other income, the amount and type of potential deductions, and the state in which the taxpayer resides, the lump sum payment may be significantly reduced by income taxes.

One other thing to be aware of is that the receipt of a sizable lump-sum Social Security payment may result in a one-year increase of your monthly Medicare Part B premium two years following the receipt of the lump sum. Applying 2014 rates, the increase may be as much as $2,769.60 for one individual or $5,539.20 in the case of a couple.

Summary and conclusion

In summary, while the file and suspend strategy has been employed by couples for years as a way to maximize Social Security benefits, it can also be used by single individuals and couples alike to create a windfall opportunity. Specifically, it can insure the payment of a retroactive lump sum of monthly benefits between retirement age and 70 in the event that there’s an unexpected change in your personal situation during that time. As demonstrated, subject to reduction by potential increased income tax liability and Medicare Part B premiums, the windfall can be substantial.

As is the case with all Social Security strategies, the key is to be aware of those that will work in your situation and to implement them in a timely manner.

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